Things Might Be Looking Up. Is this Deductible?
September 7, 2015 4:38 AM Subscribe
For reasons I won't get into, I stopped making my house payment in May, 2013. I never resumed. In June, 2015, I was finally able to sell my home, as the market had suddenly improved, and rapidly. This was a month ahead of the foreclosure auction. I don't know why the lender took so long, because I wasn't working with them at all.
Anyway, this was not a short sale. All liens were paid-in-full. It occurred to me a few days ago, that in the process of my mortgage being paid off through the sale, that approximately $26,000 in accrued unpaid mortgage interest was paid all at once.
Is that fully deductible in 2015?
Unfortunately I have no income for 2015, and I'd hate to see that large of a deduction go to waste. I've thought of a way to use it, but I'm afraid to do it and then find out it wasn't deductible. I'd like to convert a large portion of my Traditional IRA to a Roth, and use that deduction to pay the resultant tax bill.
I can think of a few reasons why it might not be deductible all in 2015, but those are just guesses. I've emailed the IRS but haven't gotten a response yet, or any indication when they will respond.
Does anyone know for certain?
Thanks.
Anyway, this was not a short sale. All liens were paid-in-full. It occurred to me a few days ago, that in the process of my mortgage being paid off through the sale, that approximately $26,000 in accrued unpaid mortgage interest was paid all at once.
Is that fully deductible in 2015?
Unfortunately I have no income for 2015, and I'd hate to see that large of a deduction go to waste. I've thought of a way to use it, but I'm afraid to do it and then find out it wasn't deductible. I'd like to convert a large portion of my Traditional IRA to a Roth, and use that deduction to pay the resultant tax bill.
I can think of a few reasons why it might not be deductible all in 2015, but those are just guesses. I've emailed the IRS but haven't gotten a response yet, or any indication when they will respond.
Does anyone know for certain?
Thanks.
Saying nothing about deductibility, one thing to check into is that unless you had a high income or were maxing out your 401k, your traditional IRA contributions were deductible when made and the only taxable amount on the conversion is the appreciation (net change in price, plus interest and dividends received).
posted by MattD at 5:53 AM on September 7, 2015 [1 favorite]
posted by MattD at 5:53 AM on September 7, 2015 [1 favorite]
Congrats on getting out alive. If you have TurboTax, you could try running through it in various scenarios. My guess, but I'm just a layperson, is that you are right, the interest paid would be deducted from capital gains income.
Did you receive a 1098 from the mortgage company?
You might ask this question (with a few more details) on the bogleheads forum.
posted by Dashy at 6:20 AM on September 7, 2015
Did you receive a 1098 from the mortgage company?
You might ask this question (with a few more details) on the bogleheads forum.
posted by Dashy at 6:20 AM on September 7, 2015
Best answer: I believe what flowergate is proposing to do is to create ordinary* income by converting the traditional IRA to a Roth**, then using the mortgage interest deduction against the tax that would be due.
I can't find a specific IRS reference to your question, but generally deductibility is tied to the year paid, not the year accrued (for example, a common year-end strategy planners recommend to clients is to speed up their January mortgage payment into December so that interest is deductible in the current tax year).
*the only income in this scenario is ordinary income due to the conversion, which is taxed the way salary and wages would be taxed. Based only on what flowergate tells us, I doubt there will be a capital gain here - for a single person, the first $250,000 of gain after the sale of a home is excluded from capital gains taxes. Unless that was one enormous market improvement or the other usage tests aren't met, it's likely not an issue.
**the entire conversion amount - original contributions plus the change in value - is considered taxable income in a conversion. The original contributions, I'm assuming, were deducted from income at the time they were made, so no taxes were paid then and they'll be due now. It's the same as it would be if it was just a regular distribution in retirement - no distinction is made between contributions and subsequent gains, the full dollar amount of the distribution is just considered ordinary income. On the other hand, if flowergate was above the income limit when the IRA contributions were made, they would have been non-deductible contributions, and Form 8606 would have had to be filed to keep track.
All of this is to say, flowergate, it's probably a good idea in this case to consult with a tax pro to make sure all the angles are covered. They can run some numbers for you to determine whether a partial or full conversion works best, etc.
posted by shrieking violet at 6:49 AM on September 7, 2015 [1 favorite]
I can't find a specific IRS reference to your question, but generally deductibility is tied to the year paid, not the year accrued (for example, a common year-end strategy planners recommend to clients is to speed up their January mortgage payment into December so that interest is deductible in the current tax year).
*the only income in this scenario is ordinary income due to the conversion, which is taxed the way salary and wages would be taxed. Based only on what flowergate tells us, I doubt there will be a capital gain here - for a single person, the first $250,000 of gain after the sale of a home is excluded from capital gains taxes. Unless that was one enormous market improvement or the other usage tests aren't met, it's likely not an issue.
**the entire conversion amount - original contributions plus the change in value - is considered taxable income in a conversion. The original contributions, I'm assuming, were deducted from income at the time they were made, so no taxes were paid then and they'll be due now. It's the same as it would be if it was just a regular distribution in retirement - no distinction is made between contributions and subsequent gains, the full dollar amount of the distribution is just considered ordinary income. On the other hand, if flowergate was above the income limit when the IRA contributions were made, they would have been non-deductible contributions, and Form 8606 would have had to be filed to keep track.
All of this is to say, flowergate, it's probably a good idea in this case to consult with a tax pro to make sure all the angles are covered. They can run some numbers for you to determine whether a partial or full conversion works best, etc.
posted by shrieking violet at 6:49 AM on September 7, 2015 [1 favorite]
Yes, the interest is deductible in the year paid. You should try to get a statement from the lender so that you get the amount right. Other deductions you should add on are property taxes paid in the same year and anything else you find on Schedule A, like medical expenses. If your income is zero, then many medical expenses will be deductible because they are greater than 10% of income.
You may be able to convert somewhat more traditional IRA money than just the deductions because the 10% tax bracket extends up to $9225 for singles and $18,450 for married. If you anticipate significantly higher income in future years, it may be a bargain to convert some additional part of your IRA at a 10% rate. But then this also raises the threshold for medical deductions.
You should get an early copy of Turbotax or similar in December and work out some scenarios to see exactly how much of your IRA you can convert at the lowest tax rate. Unfortunately, you have to do the conversion before the end of 2015 to use your deduction. You can't wait until April when you file taxes to figure out how much you should convert.
Another consideration is whether you are getting Obamacare. Eligibility for Medicaid and regular Obamacare insurance depends on your Modified Adjusted Gross Income and that includes Roth conversions before any Schedule A deductions. So for example if you had $26,000 of Roth conversion income and $26,000 of deductions, although you would have zero income for income tax purposes, you would have $26,000 of income for Obamacare qualification because Obamacare MAGI is before deductions.
posted by JackFlash at 10:20 AM on September 7, 2015
You may be able to convert somewhat more traditional IRA money than just the deductions because the 10% tax bracket extends up to $9225 for singles and $18,450 for married. If you anticipate significantly higher income in future years, it may be a bargain to convert some additional part of your IRA at a 10% rate. But then this also raises the threshold for medical deductions.
You should get an early copy of Turbotax or similar in December and work out some scenarios to see exactly how much of your IRA you can convert at the lowest tax rate. Unfortunately, you have to do the conversion before the end of 2015 to use your deduction. You can't wait until April when you file taxes to figure out how much you should convert.
Another consideration is whether you are getting Obamacare. Eligibility for Medicaid and regular Obamacare insurance depends on your Modified Adjusted Gross Income and that includes Roth conversions before any Schedule A deductions. So for example if you had $26,000 of Roth conversion income and $26,000 of deductions, although you would have zero income for income tax purposes, you would have $26,000 of income for Obamacare qualification because Obamacare MAGI is before deductions.
posted by JackFlash at 10:20 AM on September 7, 2015
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Sale of home. If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of the sale.
Although note that if you had no income in 2015 This won't result in any net benefit to you, as a deduction is distinguished from a credit. A deduction functions to reduce your taxable income before the taxes are calculated - if you start at zero this won't help much.
posted by Karaage at 5:35 AM on September 7, 2015